Money, and Why Government Shouldn’t Touch It

It is arguable that the most powerful tool the government possesses is the issuance and monopoly over money. Government can maintain control over arms, mail services, defense, courts, and education, yet the most effective way to keep hegemony over a people is to control their money. The issuance of bills, the “deeming” of the money’s worth, the control and manipulation of interest rates and credit, etc. This is how the state can truly maintain a grasp over everything. Money is the core of exchanges, you control those exchanges and you can control how people live their lives. But what is money exactly anyway? What value does money have? Why would the world’s governments want to control it? What are the effects of government control of money? What forms of control does the government have? I’ll try to answer these question using the knowledge I have gained over the past few years of private study, and hopefully shed some light on what is otherwise a confusing, although important, topic.

But What is Money?

Money at its purest is a tool of exchange, thats it. Since no one can produce everything they need to prosper on their own (Not in a literal sense, think more modern, cell phones, cars, food, electronics, etc.), we have to engage in exchanges with people who have things that we want. The old school way is that of barter, the direct exchange of goods or services that can be immediately consumed. For instance, a baker would like some tomatoes, so he would go to the tomato farmer and trade a loaf of bread for x amount tomatoes. It is a simple system. But it can get very complicated when society gets larger and more advanced. If we had a barter system in place right now, a teacher who wants some meat would need to find a butcher who wants to learn something. It can get extremely confusing very quickly.

Money serves as a medium in these exchanges. Instead of directly giving a person one good (bread) in exchange for another good (tomatoes), money takes that place. The baker could give the farmer $5 for tomatoes, and in turn the farmer could pay $2 for a loaf of bread. The same goes with the teacher and the butcher. This allows one good (money) to represent the “value” of what one is willing to give up in exchange for something in return.

In all the hypothetical exchanges above, it is worth noting that both parties in the exchange (The farmer and baker for instance) both believe they are benefiting in the exchange. This is to say that what the baker is giving up (bread) he values less than what he is receiving (tomatoes). All exchanges are like this. The parties involved believe that they are both mutually benefiting from the exchange (whether or not that is actually the case is irrelevant, both parties believe that they will gain satisfaction). The amount of satisfaction one gains from any given good, service, or exchange is completely determined by the individual. It cannot be measured by numbers or statistics. To say the baker enjoyed the tomatoes 43% more than the loaf of bread is completely illogical. It is a statement that makes no sense. Satisfaction is completely subjective.

So to recap what we have so far:

Exchanges are the core of a functioning society. (No one makes is own car, drill for his own oil, and refines it into gas)

Money is a tool of exchanges.

All exchanges are deemed beneficial to both parties involved. (The baker preferred tomatoes to bread, and vice versa)

The amount of satisfaction of a given good/service/exchange can only be determined by an individual, and cannot be measured.

What Value Does Money Really Have?

Normally we think of the value of goods in how much money they are worth, but what is the value of money? In essence, it’s value is in its use in the role of exchange. This is why we work (Which in turn is an exchange of labor for a good, in most cases, money). Money isn’t necessarily sought after for the sake of it, but because we can at some place and time exchange it for something that we believe will bring us more satisfaction. Also, money itself is a good, and like all goods, its “value” is determined by supply and demand.

For a basic lesson for those who do not know, when the supply of something increases and the demand stays the same, the price tends to decrease. Inversely, when the demand for a good or service increases and the supply stays the same, the price tends to increase. So, when the Federal Reserve System (The Central Bank of the United States) creates a stimulus or bailout package, it is creating new money and putting it into the economy, which will increase the supply of money and not necessarily increase the demand for money. This will decrease the “price” or the value of the money, therefore, raise the price of anything related that is measured in dollars. This is a side effect of inflation, which is an increase in the money supply. This is also why any increase in the minimum wage never tends to make anyone better off. The increase in the wage will simply (attempt to) match the level of price inflation.

Many people believe, especially many libertarians, that the current dollars we have now are not real money. But what does this mean, real money? As I put above, money is simply a tool for exchanges, so anything used in an exchange is technically money. (Even if it is not considered so by many) What people are referring to is the fact that our dollar (A Federal Reserve Note. Look at top of a dollar bill if you have one on hand), is not backed by a commodity. Throughout most of history, money has existed in the form of a commodity, like salt, spices, gold, silver, copper, sea shells, and rocks. Most commonly, a mixture of gold and silver has been history’s number one form of money. Why these two? They possess good “qualities” for money, they are scarce (remember supply vs demand), the are easily malleable, they don’t decompose or rust over time, they can be easily measured, and are easy to mold into desired shapes or sizes. What used to happen, was that people would put their gold or silver in banks, and these banks would issue receipts for the depositor. These receipts could be used as money, not because the paper they are printed on is worth anything, but because whoever holds that receipt can go to the bank and get the gold and silver back using that receipt. (Carrying a bunch of receipts is easier that carrying around a sac full of gold or silver coins) This is how money worked for a long time.

Most countries today do not back their currency by any commodity. Things like gold and silver are not official money (They can be used in a transaction if both parties agree to it though). The reason non-commodity paper bills, called fiat money, have any value, is because they are backed by the “Full Faith and Credit of (Insert Government Bank)”. Furthermore, fiat money is not limited by scarcity, so by printing huge amounts of money, a central bank can destroy the value of the money they are printing by creating too much of it. (A scarce good is one that if the price is zero, the demand will be higher than supply, for instance, if guitars were free, people would take as many as they could and their would not be enough guitars for everyone. Conversely, air has no price, because the supply of air far outstrips the demand for air, even though we cannot live without air and can live without guitars. So there is no need for air to be economized) Imagine if gold could be mass produced to the point where everyone could have the amount the desire. This would cause gold to be worth nothing, so it is the fact that there isn’t enough for everyone that gives it it’s value.

Let’s do another quick recap:

Money is primarily sought after not because we can immediately consume it (like food or water), but because it can be used to exchange for things we do want/need.

Money is a good, and like all goods its price value can be determined by supply and demand.

There isn’t (necessarily) a “real” form of money. Money is a tool of exchange.

Historically, money has been either in the form of, or backed by a scarce commodity.

Fiat money, is money not backed by any commodity. Most countries on earth either issue or use a form of fiat money.

If money can be made non-scarce with relative ease, it will lose its value, thus raising the price of anything it is used to buy.

Why Does Government Want to Control Money? And What is the Effect of it’s Control?

As we saw above, things like gold and silver have value because they are scarce, they cannot just be made like paper money. So what am I getting at? When the dollar was backed by gold (We permanently got off the gold standard in the early 1970’s), anyone could go to the bank with their dollar and redeem it in gold or silver, a kind of insurance. If banks lent out too much money, i.e., more than they had in their vault, and people came to redeem their money’s worth, the bank would not have enough gold or silver to cover all the money they issued. This limited (in a good way) the amount of money and risk taking that banks would make. In a politicians eyes, this limited the amount of money they could spend on idiotic civil projects and war. If banks could only issue more money, and make more loans without the risk of defaulting on their depositors, the government would have more money to spend and more money to tax. In 1913 the Federal Reserve Act was passed. This created a quasi public, quasi private central bank that was “blessed” by congress the power to control the issuance of money and the delivery of money. I won’t get into the details of the Fed in this article, they are a complicated monster, however I will discuss the effect they had on the dollar.

In 1971, president Nixon (The not crook) took us off the gold standard. (Called the “Nixon Shock”) While the Federal Reserve had control of the dollar since 1913, they couldn’t print it endlessly without risking defaulting on deposits, just like the bank example above. Now that they were no longer limited by this, they were given free reign over the printing press. Since then, the amount of money in the economy has increased practically every year, especially after the ’08-’09 bailouts and “quantative easing” taken into affect by the fed. This has caused a surge in prices over the years. (I’m sure we all remember the stories of our grandparents bragging about 25 cent a gallon gas)

When new money is printed by the Fed (Mostly just added electronically to bank sheets), the first people to receive these new funds get an unfair advantage. In that, since the money has not entered into the economy yet, it still maintains its value. So the first people to receive these loans, normally corporations who lobby congress heavily, or other government “favorites”, get “free” money. Once they have received this money and spent it, the value of all the other dollars in circulation will drop in accordance to the amount money printed. (This is assuming that all other factors are aside, a whole economy is unbelievably complex, so much so that I would never be able to cover it all here. Not that I can anyway.) This allows the government either directly, or through special interests, to use “free” money to spend on things they desire, and subsequently, deriving us of the value of the money we hold in our bank accounts.

Since 1913, when the Fed was established, it has devalued the dollar by about 97% of it’s worth. This means the dollar of 2011 is only worth 3 cents compared to the dollar of 1913. If this isn’t downright robbery, I don’t what is. But the true genius behind price inflation is that the deprivation goes largely unnoticed. How would the average person know that the government is one of the prime reasons their favorite steak jumped up in price, or the gas for their car? They tend to blame corporations for “price gauging” or robbery or greed, and then vote to have them regulated. This puts even more control of economic activity in the hand of a group of bureaucratic idiots.

Recap:

We left the gold standard behind in 1971 and have been fiat ever since.

Commodity money limits the ability of banks to put their customers deposits at risk by lending too much. It also limits how much government can take from society.

Without the “grounding” affect of commodity money, central banks tend to pump out more and more money as time goes on.

An increase in the money supply (Inflation) tends to decrease the the value of an individual dollar (price inflation).

Governments use their central banks to get “free” funds and give bonuses to their special interests. Afterwards, the devaluation hurts the money we earn and keep.

Rising prices is often blamed on private companies, and via voting, they end up being regulated out of a “fairness” doctrine.

What Forms of Control do Governments Use?

Outside of the issuance and supply of money, governments (through their central banks) have other means in which they can determine or affect how money is used. Their are taxes and subsidies. We all know what taxes are, but the government often uses taxes to discourage certain activities or kinds of behavior. For instance, proposed soda taxes that try to turn people away from consuming soft drinks by artificially raising the prices using taxes. Carbon taxes are another example. Often the government will try to raise funds by “punishing” the use of certain goods or services with a high tax. Unfortunately, this not only is often accepted by many people (who for some reason love to regulate, or try to regulate “good” behavior), but artificially lowers the demand for that good or service, which can hurt the suppliers who’s goods are being taxed.

On the other hand, we have subsidies. Subsidies work in the opposite direction of taxes in terms of market manipulation. They are used to promote a certain type of activity, behavior, or good. Some examples are the corn subsidies, where farmers are paid to grow more corn instead of other crops (Or sometimes, not to grow corn. I know, confusing right?). Also, there are tax subsidies on buying “environmentally friendly” cars. These attempt to alter market supplies and demands through rewards. One of my favorite examples of government subsidies is the offshore oil subsidy. The government would heavily subsidies oil corporations to drill farther away from the shore. Generally speaking, the deeper the water, the more difficult it is to drill in. Thus, the more costly. So normally these companies would not waste their resources and capital on such projects, but when a massive government subsidy can not only cover, but surpass that cost, they will jump on what they deem to be “easy money”. Remember the BP oil spill? Yeah, guess why they were out that far…

Manipulation of the Time Market

I am dedicating a special section to this form of monetary control, for it is the most dangerous next to hyperinflation. The Time Market, what is that exactly? When I say the Time Market I am referring to interest rates. Yes, the kinds on bank accounts, credit cards, and loans. It is a charge levied on the return of money. This is how creditors make money. Interest rates are normally determined by people’s time preference. Their time preference is a measurement of desire for current goods over future goods. In other words, people tend to want things now rather than later, and the time preference is the measurement of how bad they want things now. When many people prefer to have goods (Like houses, cars, or anything really) much sooner rather then a little later, interest rates are higher. When people tend to not want things that much right now, they tend to be lower. If people are saving a lot of money, this is a sign of a low time preference. Thus, interest rates will tend to come down, when rates come down, people will often try to get a good loan or deal. This is how credit markets function. People save money in banks, banks loan out based off how much money is in the bank, and the people who borrowed from the bank will make payments with interest to the bank so they can make a profit.

With that out of the way, when the government wants to “stimulate” economic activity, either because they deem the market to be too slow or simply want to force “improvements”, they will not only print and loan more money (as we learned above), but will also lower the interest rates. Because these rates are lower, banks tend to lend out to other banks more often, and tend to lend out to more people as well. (The amount of people who are looking for a loan doesn’t necessarily change, so the banks will then lend out to people who they initially deemed unfit for whatever loan they were looking for.) With this new “artificial” rate, (I call it artificial because it does not truly represent society’s current time preference) people are able to get loans that they were otherwise be rejected for, or wouldn’t risk doing. This is because this low rate makes it appear as if there are more available savings then there actually are. The famous example put forth by Austrian economist Ludwig von Mises describes this effect as a mason who is building a house. He only has a limited supply of bricks and must plan to build his house with the most efficient allocation of his resources (Bricks). The affect of the artificially low interest rate is like making the mason believe he has more bricks than he actually does, so he plans a larger house than he could normally build. At some point in the construction, he will realize that he has run out of bricks with only half of a house built. He must then take apart the house he built, re-plan his house, and build it more carefully.

The part in that example where the mason realizes that he has run out of bricks is what happened to our economy in ’07-’08. We realized there were not enough resources to cover all of the expansive projects we were undertaking (particularly in the housing market and construction market. Remember all of those developments that popped up in the last ten years or so?), we realized that it was unsustainable and we had to stop, call back faulty loans, fire workers who were wrongfully hired, and try to reallocate resources to where they should normally go. This is the boom and bust cycle, also called the business cycle.

I just gave you the view of the current recession using the Austrian Business Cycle Theory developed by von Mises and furthered by Friedrick Hayek. Government manipulation in the time market wrongfully tricks people into allocating resources in unsustainable projects. The damage is done not in the bust period (recession), but in the boom phase. The recession is necessary to properly reallocate all those resources. Unfortunately, government (and many people) do not recognize this, and attempt to stop a recession by doing more of the same, i.e., lowering rates more and creating more money. This is why the great depression dragged on for so long, and why we cannot seem to get out of our current economic predicament.

One final recap:

Taxes are often used to punish or discourage a certain type of behavior or good. Subsidies do the opposite, they encourage or promote it.

Interest rates are a reflection of individuals’ time preferences.

A time preference is a measurement of how much people want something now as opposed to later.

An increase in savings means people have a lower time preference, thus interest rates will drop.

Low interest rates often encourage people to take loans, but lender are careful to pick the right people so they, and their investors, will not lose money.

Central bank manipulation of interest rates cause the business cycle, a period of intense growth followed by a hard crash.

The only way out of a recession is to reallocate those misused resources, but, governments often try to stop what they see as harmful economics by doing more of the same market manipulation that caused the problem in the first place.

Conclusion

Government control of money almost always end in either disaster, or stunted economic growth. No amount of bureaucrats can determine how much people need a certain good. The laws of supply and demand will do that. Since people’s preferences, satisfaction, and values cannot be measured by anyone but the individual, central control and command over an economy is impossible and self destructive. Mankind is most prosperous and most free when we are left to make our own decisions based off our own values. Having a sound money that holds its worth is key to this. I hope I was able to shed some light on a few things here, and I encourage you to do even more research on your own, for in no way are you immune to the affects of government monetary control. Best of luck.

About Shawn Kelly

Shawn is a student and father who first took to the ideas of liberty during Ron Paul's first presidential campaign. He now is pursuing a career in economics, the understanding of which he believes is paramount for those who seek a free society.

Vernon I was simplifying for the sake of those who may not know much on the topic.

“This created a quasi public, quasi private central bank that was “blessed” by congress the power to control the issuance of money and the delivery of money. I won’t get into the details of the Fed in this article, they are a complicated monster, however I will discuss the effect they had on the dollar.”

I believe I established the Fed’s “interesting” existence here, if this did not suffice I apologize. I did not want to get into fractional reserve banking here, I kind of wrote it as an “Intro” to the topic.

True that most of the money is created at he local level. You want to buy a house, the banker electronically creates a debt for you and the title of the house passes from one person to another. The seller gets electronic credits in his account and those credits are moved around within the banking system as he buys things. No money really changes hands.

The fictional electronic money created is backed buy the house mortgaged… so it is actually backed by something more valuable then gold or silver.The money that needs to be paid back exceeds the money borrowed… that total sum does not exist yet… it has to be created by other people borrowing… hence the control on inflation.

In this system you can exchange paper money for shit and it will still work. You borrow 10 lbs of shit today to fertilize your garden… but you have to pay me back tomorrow with 50 lbs of shit. You might be able to manufacture 10 lbs of shit on your own over night to pay me back… but you will have to scramble to get 50 lbs of shit. Hence, shit now becomes valuable because you need it to pay me back tomorrow and can not easily acquire it. That is how money works in the Federal Reserve System.

The system is ingenious…. the only problem here is that the government can borrow any amount of money it wants with no real collateral. They just print up a Treasury Bill and sell it to the Fed. Then they have to pay that back plus interests…. of course same rule applies… the principal plus interest does not exists yet… so they have to borrow more in order to pay it back. It is a national Ponzi Scheme.

The key difference between the US government an the rest of us is… we have to put up collateral for money we borrow. How much we can borrow is limited by real assets that we own. The Federal Government does not have to put up assets. They can borrow without limit and run the deficit up to infinity. The value of our cash is devalued in the proportion, a concept we call inflation.

The system can work if the government borrowed slowly. A reasonable rate of borrowing would be one where they increased the debt at a rate more or less equal to the rate of the population growth or the rate of economic growth. When they double the debt in a mater of two years it does nothing except dilute the currency in a manor that is extremely obvious to everyone who is in business.

My goal as an individual businessman is to increase my prices faster then the government is increasing debt/printing money. The error of the government is that when they increase the debt/money supply so fast… people catch on and respond accordingly by raising prices as fast as they can.

That is the real danger of fiat money. Money is a good, and fiat money is one that can be created very fast and at almost no cost. To “create” more gold you must mine, hire workers, take loans, get machinery, etc There is almost no way to rapidly devalue a gold backed currency (assuming of course 100 percent reserves in banks). Real assets’ own scarcity is what maintains its value.

There has never been a case in world history where gold fiat has worked to improve the conditions of the general public. It has only worked to concentrate wealth in the hands of banking interests. This was the case with the Bank of England and the causes of the American Revolution, starting with the Currency Act of 1764. It’s interesting to note that the World Bank has recently embraced the gold standard.

A debt-free currency means an end to government borrowing plus an end to fractional reserve lending. There is no need for government to borrow gold or anything else, and no need to privatize the national money supply under a central banking scheme.

Have you thought about applying to Mises University? I think the next one one can apply for is in 2012. Mises Academy (online) and George Mason or Grove City are kinda the only other places to formally study Austrian economics

I would love to do some Mises Academy/University but money is very tight. I would also love to be at George Mason U, but I have a one year old son and and 85 year old grandpa that I take care of. Can’t be somewhere that I can’t drive to. (Reasonably anyway.)

Funny you mention Grove City, I was looking into it a while back and noticed they are a formally Christian school. One that would attend there would need to go to 16 church services a semester in order to get credits. I am an Athiest, but laughed at the irony that the place I would love to study is the place I would be forced to take part in something I can’t stand. Haha. My luck.

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